Study: Audit Committees Rubber-Stamp Management

When it comes to appointing and dismissing auditors, management is still "the driving force."

While audit committees have become much smarter and more active since passage of the Sarbanes-Oxley Act of 2002, they are still feeling out their new authority. Even though they wield more influence than ever over the hiring and firing of auditors, for example, management continues to hold greater sway. And despite their new responsibility for resolving management-auditor disputes, many audit committees are still reluctant to do so.

Those are some of the findings of a new study by accounting professors at Boston College and Northeastern University, “Auditor Experiences of Corporate Governance in the Post Sarbanes-Oxley Era.” The study follows up on a similar report by the same authors, which was based on a 2000 auditor survey.

“The purpose of the current study,” write BC’s Jeffrey Cohen and Northeastern’s Ganesh Krishnamoorthy and Arnie Wright, “is to capture the experiences of auditors in their interactions with the audit committee and board in the post-SOX environment.” In particular, the professors wanted to find out how those interactions affected the audit process, such as the “resolution of contentious accounting issues.”

For their latest survey, conducted in 2006, Cohen et al. interviewed 30 managers and partners from the assurance practices of three Big 4 firms. Among other things, the auditors were asked to define corporate governance and its role in the audit process; identify who has the most influence in hiring and firing auditors; and tell how the nature and extent of corporate governance in the audit process has changed over the last five years.

Before Sarbox, auditors often found audit committees playing “a passive, ritualistic role,” the study reports. But now auditors say committees have become “substantially more active, diligent, knowledgeable, and powerful.” Whereas auditors and committees met only two or three times a year in 2000, today they meet over six times a year on average. And unlike formerly, audit committees have become aggressive questioners.

“This change can be explained by audit committee members seeing their role more as watchdogs and taking their duties and responsibilities very seriously,” the professors write.

When it comes to appointing and dismissing auditors, however, management is still “the driving force,” according to the study. Yet Sarbox Section 301 gives audit committees direct responsibility for retaining auditing services. “We acknowledge that readily in our engagement letters,” commented one auditor.

Indeed, some auditors reported that CEO involvement in retaining audit firms has been growing since passage of Sarbox. “I think CEOs are starting to realize, the audit firm can have a significant impact in my business,” explained one.

Meanwhile, as for resolving disputes between auditors and management (another duty prescribed by Section 301) audit committees still tend to “play a passive role.” About half of the survey respondents said that discussions with audit committees didn’t help resolve disputes with management.

Moreover, according to the study, management and auditors often try to settle disagreements first, then bring the settlement to the audit committee. But is that such a bad thing? “It can be a good thing, but there can also be a worry that management doesn’t like to bring things up in front of the audit committee,” says Northeastern’s Wright. “You don’t want important matters to be swept under the rug.”

Yet the study indicates that many audit committees prefer to be overseers of disputes rather than mediators, adds Wright. What’s the difference? “Being a mediator, you hear both sides,” he explains. “You are an independent party acting in the best interest of the shareholders and company. You can independently come up with the right resolution.”

On the flip side, “you don’t want the audit committee to have to deal with every problem,” says Wright. He notes there is no requirement that all matters be brought up to the committee. Still, “the worry is that disagreements can somehow miss the system.”

The reason for management’s strong sway over auditor appointments is pragmatic, Wright says. Since management works with auditors on a day-to-day basis, audit committees are more inclined to pay heed to its judgment. “Even though the audit committee does the formal rubber stamp, it’s really management who [advises whether] they want to go with this audit firm, or whether they have problems with them.”

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